That one word assessment of the Geithner plan, as previewed in the New York Times tonight, comes from reader Scott, and is good enough to print.

I am so disgusted with this entire proceeding that I am going to dispatch it quickly.

Let’s start with the basics. The US banking system is insolvent. Got that? Insolvent. That does not mean every bank in the US is toast, in fact quite a few are probably just fine, and another large group is no doubt hurting and undercapitalized, but a couple of years of not shooting themselves in the foot again would enable therm (via earnings) to rebuild their equity bases sufficiently to proceed more or less as normal.

The problem is that a significant portion of the very biggest banks are insolvent. And on top of that, most of them have very large capital markets operations which have bean the nexus of credit intermediation. The regulators spent the last decade plus being in studious ignorance of those businesses, at least the complicated ones where all the risk resided. The SEC never was very interested in bonds, and the Fed took a hands-off, “let a thousand flowers bloom” approach to risk management, derivatives and what was called innovation. Author and market observer Martin Mayer warned “a lot of what is called innovative is simply a way to find new technology to do that which was forbidden with the old technology.”

But the history of major banking crises unambiguously shows that insolvent financial institutions need to be resolved. There are variations on the theme: the government can take them over and recapitalize them, clean them up and re-sell them, a la Sweden; you can wipe out equity investors and bondholders; you can try new twists, like various good bank proposals that have surfaced lately (making new entities out of the deposits and good assets and leaving the dreck with the existing bond and shareholders). While there would be many important details to be sorted out, this is not path breaking, except in the scale at which it needs to occur. And now, having had four actute phases of a credit crunch, the Fed and other central banks have plenty of liquidity facilites ready to deal with any initial overreaction. Rest assured, although radical measures would not be pleasant or easy, there are plenty of models and precedents.

But…here we have another scowling Treasury secretary, with a bit more hair than his predecessor, serving up the same fatally flawed approach as before: let’s just throw money at the banks and hope they get better. This is tantamount to using antibiotics to treat gangrene. You waste good medicine and the progression of the rot threatens to kill the patient.

In fact, the state of affairs may be even worse that I thought. I had grumbled about the fact that the earlier leaks of this plan, like the MLEC and the TARP, seemed little more than a sketch, when its success or failure founder on key details.

The elephant in the room is how do we solve the heretofore insurmountable problem that the market price of the bad assets is well below what the banks are willing to sell them for? Paulson was unable to find a way to finesse the problem to get private investors to pick up even a cherry-picked portion of the junk in the MLEC incarnation; in TARP, he (presumably) planned to have Uncle Sam buy the paper at a price the banks would find acceptable but somehow camouflage the subsidy. He abandoned that course of action quickly, perhaps because the magnitude of the payment over market prices would be so large as to be politically explosive were the bagholder taxpayer ever to find out.

There is no evidence in the various elements leaked that this impediment has been overcome, which raises the real possibility of a Paulson-like seemingly bold advance followed by an equally hasty retreat. Inviting investors in with you on the buy side does not address the issue of the pricing gap, unless the deal with the investors is intended to help obfuscate the overpayment to the banks.

Note I have no objection to equity infusions if accompanied by sufficient ownership, controls, and a methodology for the goners, say taking over or putting into receivership. No private equity investor would put 20% into a company without getting lots of goodies, such as veto rights, antidilution provisions, a board seat, etc.

Now in fairness, Geithner may treat the banks more consistently than Paulson & Co. did. But that is cold cheer if the basic approach is still fatally flawed.

In fact, the present course is the worst of all possible worlds. AIG has demonstrated that a player deemed to by systemically important has a blank check. Not only did they get additional dough with few questions asked, they got improved terms on their initial loans. Let me stress, for those not familiar with the ways of deal-land: if you ask investors for money and maintain it is enough to achieve X (get you to break even, get your first product launched) and then come back not having done what you said you promised, the next round is on MUCH more punitive terms. Having a party that badly underestimated its needs come back, get more dough, and get relief on its inital loan is from an alternative reality.

In addition, AIG had given large numbers of staff very large retention bonuses. This is when the loans per employee are $1.4 million. Now the retention bonuses may very selectively be warranted, but they have been handed out like candy, and AIG is know for generous pay, so even if extra comp might have been necessary, query whether at this level. Given the less than rosy hiring conditions in the insurance industry, a lot of these payments appear flat out unnecessary and were thus effectively looting right under the government’s nose.

Thus, the banks get funding on an open-ended basis, with no requirement to write down or sell the dreck. And even if some miraculously does get unloaded via this process, we wonder how far it will get to really cleaning up the banks. Ken Rogoff estimates US credit losses at $2.0 trillion; this plan appears likely to fall far short of that, which means we still have a lot of sick banks, just somewhat less so. (We’ll need to wait to see how this unfolds, but since the banks have no reason to part with bad assets and take a writedown, this is the scenario they are trying to avoid, we still have crappy assets being funded at fictive prices, but this time by you and me rather than by Citigroup). The failure to clean up the banks and write down bad assets was a big contributor to Japan’s lost decade.

Now to get to the punch line, let us turn to the New York Times. The headline “Geithner Said to Have Prevailed on Bailout,” is already bad news, since as we have discussed, Geithner is a living, breathing example of cognitive regulatory capture. But here is the troubling bit:

In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.

Mr. Geithner, who will announce the broad outlines of the plan on Tuesday, successfully fought against more severe limits on executive pay for companies receiving government aid.

He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.

Because of the internal debate, some of the most contentious issues remain unresolved.

In other words, Geithner followed the Paulson script of pushing hard to make the bailout industry friendly, to the extent of compromising the effort to get the plan fleshed out in adequate detail.

We’ll see if the notion of a $500,000 salary cap survived. Lucien Bebcuck, Harvard Law professor and corporate governance expert, pointed out that in fact, that provision is not terribly restrictive. There are no limits on deferred pay, pensions, or incentive compensation in the form of equity. And executives have often taken non-recourse loans secured by shares.

The plan is terribly sketchy. Even the numbers have not been nailed down:

It intends to call for the creation of a joint Treasury and Federal Reserve program, at an initial cost of $250 billion to $500 billion, to encourage investors to acquire soured mortgage-related assets from banks.

The Fed will use its balance sheet to provide the financing, and the Federal Deposit Insurance Corporation might provide guarantees to investors who participate in the program, which some people might call a “bad bank.”

A second component of the plan would broadly expand, to $500 billion to $1 trillion, an existing $200 billion program run by the Federal Reserve to try to unfreeze the market for commercial, student, auto and credit card loans. A third component would involve a review of the capital levels of all banks, including projections of future losses, to determine how much additional capital each bank should receive.

The capital injections would come out of the remaining $350 billion in the Troubled Asset Relief Program, or TARP.

A separate $50 billion initiative to enable millions of homeowners facing imminent foreclosure to renegotiate the terms of their mortgages is to be announced next week.

And my sense that Team Obama is making this up as they go was confirmed by an e-mail from Robert Radano:

The Senate received no briefing, no documents. Press reports, leaks mostly, are as accurate as anything the Admin. has discussed with the Hill.

There are only two conclusions to draw from this. Either Treasury has not yet decided on a plan. Or for some unknown reason has decided not to confide in the Senate Banking Committee.

The markets have anticipated both a stimulus bill and a comprehensive TARP 2. Instead, markets will get a stimulus bill with marginal value and a muddled TARP.

As one astute reader commented yesterday:

At least Paulson announced his plans. Not that he ever did anything he announced, but that’s a small technicality. These guys can’t even make an announcement.

Let us not forget that Paulson did manage to dispense the better part of $350 billion in a blinding show of Mussolini-styled corporatism. The new Treasury secretary exhibits similar Italian fascist tendencies, with even less ability to make the trains run on time.

96 comments

According to this article in the New York Times (http://www.nytimes.com/2009/02/10/business/economy/10bailout.html?_r=1), the Obama Administration, under the advice of Treasury Secretary Timothy Geithner, will unveil a new bank bailout plan tomorrow which will “[abandon] any pretense about limiting the moral hazards at companies that made foolhardy investments, [and] will not require shareholders of companies receiving significant assistance to lose most or all of their investment.”

We’ve tried this approach since October 2007. It has failed every single time, and the nth iteration, if allowed to pass, will fail once again.

The entire venture of bailing out U.S. banks by purchasing or guaranteeing their assets is based on the premise that the market is somehow failing to identify their true value. Secretary Geithner wants to hand out guarantees and swap “cash for trash” in the hopes that, somehow, these assets will someday recover in value, and the taxpayer will be made whole.

Secretary Geithner could not be more mistaken. If he is allowed to implement this plan, taxpayers will ultimately be saddled with even higher losses than they have already borne, as the credit quality of these assets continues to deteriorate.

The NYT article claims that “there is no market value” for these assets, because they are not trading. In reality, there are plenty of people who would pay 20 or 30 cents on the dollar to take them off the banks’ hands. However, the banks will never sell the assets at this price, because to do so would expose their own insolvency. In New York, Chicago, and the other financial centers of the world, these securities could easily trade at such depressed values, because that is what they are worth. Only Washington policy-makers possess sufficient hubris and magical thinking to believe they “know better than the market,” and can turn a 20 cent security into an 80 or 100 cent one just by holding on to it for awhile.

If there’s no one in the market willing to take the bet that these assets are worth more than 20 or 30 cents on the dollar, why should Secretary Geithner be permitted to place that bet with the collective earnings and savings of U.S. taxpayers?

I believe it was an act of gross injustice to ask taxpayers to bear even one cent of the cost for the bad loans made by the banks. Those costs *should* have fallen on the banks’ shareholders and bondholders, who raised no alarms as executives levered up the banks’ balance sheets to place huge bets on real estate, (and even paid them lavish salaries for doing so!). However, even if you once believed that such an approach could save our banking system, surely you must agree that the taxpayer has been asked to bear enough, and a new approach is needed.

The fact is, the market has already pronounced these banks insolvent. They continue to exist only as beneficiaries of the Fed’s and Treasury’s largesse. I am as free market as they come. I voted for your Libertarian opponent. But even I would prefer either temporary nationalization or, better yet, a “cramdown” conversion of bank debt to equity (and dilution of current shareholders), to the continued transfer of wealth from taxpayers to bank shareholders and executives that Secretary Geithner’s plan represents.

The points I have made in this email are the same ones being made by economists and traders on the financial news every day. As the Chairman of the Senate Finance Committee, you are in a unique position to ensure that taxpayers are not stuck with the raw deal that the Obama Administration’s plan represents. Please, stand up for the taxpayer, tell the truth about this plan, and oppose any further bailouts or guarantees for bad bank debt.

The further reliance of Fed guarantees of worthless assets reminded me of the “The Creature From Jekyll Island.” by Griffin.

If anyone had any doubt that the Fed was created by the big banks _for_ the big banks, current events should remove it. Instead we either get heads in the sand or looking in every direction away from the elephant in the room.

That’s why this will continue to get worse until the faith and credit of the USA will be seen as worthless , which includes its currency. Until then, try to enjoy the bumpy ride and hope for better on the other side.

Yeah, not much of a review, but I’m not sure any empire collapses in a reasonable fashion. It’s collapsing because the top people feel they are immune to the aftermath of the destruction. I see Washington in spin control mode, thinking they can BS their way out of terminal cancer.

what we can see here is evolution of the strategy to stage 4 – complete obfuscation of intent thought complexity.

here is the path we have taken with this plan, and it is always the same plan – give money to the banks at no cost.

oddly the policy wonks started with clear plans, im not sure why they bothered. never the less here is the path we’ve taken.

1. Direct Trade of Crap for Cash (bad bank) — this failed because it is so transparent and previously failed as the original TARP plan.

2. Insured Assets — the attempt made here is to be able to say teh govt isn’t buying anything. this failed because someone made the mistake of explaining this to the media as “like the Citibank and Bank of America backstops”. Everyone could see this was losses to be paid later.

3. Private Acquisition of Assets Insured by Govt — this one hit sunday night. Note they pushed “private” to the head of the story to try and make it seem like the government was involved. However the follow up showed this was the same as version 2, but just a change in asset ownership.

4. (today’s) The Kitchen Sink Plan – No less than 5 different complex schemes involving at least 3 different govt agencies and some private investors, with several different numbers / ranges. This seems to me to make it impossible for even experts to quantify the risk. They’re basically throwing sand in our face to throw us off the path. By far is the most difficult to explain version to lay people. But this is most definitely an extreme propaganda tactic.

Obama supporters should be gravely concerned (the ones who are left anyway), this really is getting as bad as the Bush propaganda machine. And i donated to Obama.

Check out David Brooks column in the NYT today. Even though Geithner had no time to flesh out his plan properly, he did have time to sit down and have a long chat with noted financial columnist Bobo Brooks. It’s a doozy.

“It’s very important that we don’t look like there’s any intent of taking over or managing banks. Governments are terrible managers of bad assets. “Yes, those banks have proved masterful asset managers.

“Nor does government need to lop off the head of every C.E.O. Geithner has forced management changes in the past and says he will do so again, but he clearly leans against those who want a reign of terror. “Firing management of bankrupt bank=reign of terror. You who thought you were capitalists,are communists.

“There’s a lot of private capital out there that wants to come in. It just can’t get the financing,” Geithner insists.Translation: Theres a lot of private cash that wants to come in. It just can’t get the cash. So Geithner will just give taxpayer cash to his friends. Problem solved!

“Inviting investors in with you on the buy side does not address the issue of the pricing gap, unless the deal with the investors is intended to help obfuscate the overpayment to the banks.”

You hit the nail on the head, as usual – but of course that is precisely what the deal is intended . Public downside, private upside. This way the treasury can’t be accused of overpaying, the banks still get more than they would in the open market, and all the upside goes to to hedgies and the PE types. This will be called a tremendous success … at least until the next shoe drops…

From what I’ve read, the cap remains, but only for the most senior of executives, who are surely sufficiently resourceful to remunerate themselves through alternative channel. Other critical employees are free to cash in.

This plan resolves nothing for the reasons you describe. Worse, it does nothing at a significant cost in both resources and opportunity.

We haven’t even created a very nice zombie. The vital functions that make a banking system a banking system aren’t even there. This just some twisted banking homunculus stitched together with some spare organs borrowed from the State.

They are still in denial. They don’t wanna face the reality of the crises.They lack political courage. Geithner is weak and a banker, he will do as he is told and the bankers don’t want to bear the losses of the toxic assets.

oddly the policy wonks started with clear plans, im not sure why they bothered. never the less here is the path we’ve taken.

This is a crucial point, Early Withdrawal. I was actually encouraged by the relatively sane policies pushed by other advisors. Good thing the true font of modern American power reasserted itself. Once upon a time, we had pitiful leaders like Jackson:

"I was aware that the Bank question would be disapproved by all the sordid, & interested, who prised self interest more than the perpetuity of our liberty, & the blessings of a free republican government…"

“Tim Geithner, working with Larry Summers, my national economic adviser, and others are coming up with the best possible plan to use this money wisely in a way that’s transparent, in a way that provides clear oversight, that we are conditioning any money that we give to banks on them reducing executive compensation to reasonable levels and to make sure that they’re not wasting that money.”

I am in receipt of your detailed letter, and will respond as best I can, however, as I write, I have a luscious escort that was sent over by a large bank, and she is kneeling under my desk, and is delightfully distracting me, so may reply may not be as coherent as I would like to… oh, yeah, just like that, darlin’… I’m sorry, where was I…?

LOL, trust me, I’m well aware that’s what’s going on. I wrote the letter more for my own peace of mind and to have it on the record than out of any hope that anyone in Washington (except Ron Paul) will offer principled opposition to the bailout.

Johnson: “…decisive action to restructure large banks is almost impossible. Such action would require overcoming perhaps the single strongest interest group in the United States today.”

In an earlier post he remarks, “Speaking personally, I had no illusions about the power of the strongest on Wall Street – particularly after my experience on the SEC’s Advisory Committee on Market Information in 2000-2001.”

Re: " The US banking system is insolvent. Got that? Insolvent. That does not mean every bank in the US is toast, in fact quite a few are probably just fine"

> Right on dude, I feel that way also, i.e, there are plenty of smaller banks that did things right, banks that were honest in an old fashioned way and that there were good people out there that were running a business according to the law — and it's those banks which are now solvent, who should take over management of the toxic shit pile left behind by wall street.

Unfortunately, The Fed, the corrupt failure of a government which is virtually hanging in place by loose threads, wants to continue the charade to bail out the crooks who destroyed the system — versus turn the wall street/political shitpile over to a group of small town people that have common sense, integrity, honesty and all the right stuff that will restore confidence in The United States Of America! The small banks that are solvent are the core of The American Dream and it is Main Street that should be in control of tax revenue. This has been a circus filled with chaos, corruption and lies and if this is Obamas idea of change, then it's time for him to leave Washington!

Wake up Obama and pray to God that you have the strength and character to not fall for the crap that these piles of shit are selling us!

The last lot (Paulson et al.) may have been corrupt and “captured” but at least they could take an action. The new lot (Geithner et al.) are even worse – it seems they are completely incompetent. And I’m no fan of Paulson and his fellow GOP cronies, so that says a lot.

I want Paulson back. Somehow it didn’t feel quite as bad as it does now.

I want Paulson back. Somehow it didn’t feel quite as bad as it does now.

I have been what passes for a Paulson apologist in this neck of the woods, much to Yves’ consternation, and I remain that way. He was aggressive and decisive to a fault. He took earnest steps towards resolution based on the information he had, even if they were ill-conceived and ultimately unsuccessful.

I don’t get the same feeling from Geithner. He’s got a very long track record of gently papering over crises as best he can, deferring problems in hopes they get better.

At many times in the past, they did indeed resolve themselves, but given our outstanding obligations and the sheer volume of bad debt, this won’t magically resolve itself. Insolvency is not self-rectifying. If we do get interest rates sufficiently depressed that the assets become money good, it is only towards an even worse future, with yet lower interest rates and yet more debt. Success of Geithner’s plan would be little more than a harbinger of bigger problems later.

For goodness’ sake, let the poor debtors cleanse themselves through bankruptcy and let’s get back to work, where the talented and diligent are rewarded. The state and her people are America’s true assets, not the liens held against them by government-backed banks.

For mine a new US govt owned bank needs to be created with its purpose to start lending to the surviving US private entities (albeit with solid credit underwriting) and therefore limit the gangrene infecting the portion of the economy still with us.

Working through large banking entities that on mark to market accounting are insolvent simply guarantees the government funds are directed against balance sheet losses instead of the economy.

It seems the authorities do not want to kill banks with voting retail deposit bases that are presently insolvent but might make it under their own steam … but if they work through these banks then they need to vastly increase the stimulus volume to repair the balance sheets as well as the economy.

And if the taxpayer is going to provide that much in funds, then they should be getting ownership of at least convertible debt if not outright equity.

Finally none of this suggests the US authorities are getting any closer to actually heading off this event, as the volumes of government cash required are simply too big for people to sign off.

Lets be novel and try capitalism – its a profit and LOSS system, where firms that overpay idiotic CEOs, venal CEOs, or venal idiotic CEO’s and become insolvent go bankrupt. Shareholders are wiped out…Bondholders are wiped out. Yeah, I own bank stocks (and some reits too) – I am getting exactly what I deserve for my ignorance and inattention. I do not want to compound the problem by blaming others for my (i.e., shareholders) mistakes and inattention. I will be poorer but wiser. But I can only recover if the country recovers – and that starts with reality – take your losses!

So the first objective of the new bailout will be to encourage investors to acquire soured mortgage-related assets from banks. Like many people I thought banks were in the business of lending their own money when in reality then lend other peoples, by selling on the debt. This does mean greater liquidity but it still encourages banks not to risk assess assets properly. I would much prefer it if banks were in the business of banking rather than selling debt. While I can perhaps understand the short term motives in this, the fact that the longer term view is being studiously ignored is troubling.

The second objective is for Federal Deposit Insurance Corporation to provide guarantees to investors. I perceive this as a move to copy the UK government into the monoline business and we all know what sort of losses they have made. This can also be seen as protectionist and we ought to consider just how robust the monoline business will be in the face of competition. Plenty of banks are still highly exposed to any monoline failure especially European banks, which could cause a domino affect for US banks.

The next objective is to unfreeze the market for commercial, student, auto and credit card loans. This suggests that de leveraging is not going on and there is still a market for these loans. Anyone who has read the ‘Recession? No, It’s a D-process, and it Will be Long’ link from Barron’s will know that once de leveraging starts, you can not really turn it. All the unfreezing will not help if nobody wants the laons.

The final objective is to spend 50 billion to help those facing imminent foreclosure to renegotiate the terms of their mortgages. Which is a bit like being slapped round the face with a wet fish for all those sensible mortgage owners who will not be getting help with their mortgages. Yes many were mis sold mortgages and those responsible should be accountable in law, but helping in this way builds tensions within society. What is wrong with mortgage holidays of up to 2 years for those in trouble with agreement from the banks and with government subsidizing the banks costs for doing so.

The whole point of this bailout is to try to re-ignite demand in the US to counteract the loss of demand from those loosing jobs and those who have had access to easy credit removed. This could work except for the fact that it does very little for global demand in a time frame which stops the inevitable decline. With the best will in the world the US treasury will struggle to reverse job losses in Japan and China in the short term. The US government needs to stop focusing on banking, lending, debt, credit and needs to start thinking about sustainable job creation. Money spent on apprenticeships, scholarships, research grants, cooperative education programs, new business grants, career planning, small business planning will probably be the wisest money spent in the long run.

Geithner is a fireman spitting on a raging fire in the hope that this saves the house. He’s nibbling around the edges rather than trying to deal with the entity itself.

It’s not going to work. Banks will continue to have their toxic debt (who’s going to buy it at the price they believe it’s worth? The US government?) and they will continue to not loan money, meaning businesses and citizens will continue to not spend.

Interesting. Paulson is a clever, energetic, decisive and impassive thug. GS is a machine for producing people with those characteristics – that's what they want from their CEOs.

One of the confusing things about the last 18 months was the strange alternation between endless dithering (MLEC and successors), on the one hand, and really quite gung-ho interventions (the BSC rescue, the F&F conservatorships, the AIG rescue, the LEH bust, the sudden stuffing of $125Bn new capital into a group of surprised banks), on the other. It's hard to see these two sets of decisions as the products of the same mind.

Rank speculation of course, but perhaps the interventions were Paulson and the dithering was Geithner?

Geithner may have a real knack for turning his boss of the day into a slave of events. Not promising for Obama.

With Paulson gone, and Geithner at the controls, it will be exciting to see how the next acute phase of the crisis (no idea what or when) is managed.

The entire premis eof this program is to move the risk onto the fed balance sheet as OPbama as evidenced in the pressconf last night knows that the public isn;t buying the stimulus. No way they sell the bailout so they have to go backdoor via the fed balance sheet. Fed = bad bank

• The ‘rule of law’ in scamerica is a scam. Selective enforcement and no enforcement for select players (and to implement intentionally devious derivatives policy) rule the day. Aggregate generational corruption has turned the scam ‘rule of law’ into a well honed tool of exploitation for the now very few wealthy ruling elite.

• All banks are toast. The prudent have been pitted against the not so prudent. We are now firmly in a well planned and orchestrated mode of perpetual conflict of Strauss neocon design. This intentional divisiveness started with the grooming and unleashing of Ronald Reagan on a brainwashed public – think PATCO strike and the ‘compassionate conservatism’ of turning out hundreds of thousands of mentally ill patients on to the streets to enjoy their ‘freedom’. In the last forty years scamerican society has been intentionally coarsened by a bought and paid for corporate media that has shifted citizen motivation from a focus on desire and opportunity to a focus on fear and divisiveness. Talk radio, owned by corporations with zero allegiance to scamerica, has become a disgusting sewer of demonization and hate mongering.

• The patient does not have “gangrene”. The patient has been poisoned with deception using the scam rule of law as a tool to administer ‘measured’ doses of the poison. You can measure blood pressure, inflation, deflation, mark to market, anal temperature, bond sales, long term, short term, etc., and devise all kinds of remedial plans but they will ALL be a complete fucking waste of time. Why? Because the same disingenuous scum bags that created the scam ‘rule of law’ are still in charge and still metering out the poison.

• Now, you can argue weather or not the poison was administered intentionally as a poison by devious psychopaths as I believe, or, given remedially by well meaning bumbling idiots who just somehow or other always seem to do things that favor the bidding of the wealthy ruling elite. Either way the problem remains the same. The middle class is fast disappearing and we are approaching a two tier ruler and ruled world

• We need to go back to the earliest “historical American model” – revolution. We need a revolution in thinking and action. I believe the best peaceful approach is to begin massive street demonstrations to express a vote of no confidence in government. In tandem with the street demonstrations national election boycotts should me mounted. The electoral process in scamerica is reflective of the scam ‘rule of law’ and is totally non responsive to the will of the people. “Let’s look under the hood a minute.”, Ross Perot got 12% of the public vote and got ZERO representation in government for all of his efforts and the efforts of his constituents.

• Looks like Madoff is going to cop a plea and get a no jail time deal for his MULTIPLE Ponzi actions. Meanwhile … there is a guy doing life in prison in California under the the three strikes law. His third strike was shoplifting some video tapes for his kids for Christmas. Can we see the difference here? Its called selective enforcement. Its called a scam ‘rule of law”

In addressing our our fiscal disarray, why is the Administration and its Goldman/Citi consiglieri so fervently intent on keeping toxic assets on bank balance sheets unknown and unquantifiable?

Also in my view, here is why…:-)

First, one must perceive that the investment banks have these toxic assets on their books only because,at the end of the securitization scam, nobody would buy them.The game was over when everyone knew that the ratings agencies (i.e. Moody's, S&P) were asleep at the wheel – or worse.Previously and typically, the ongoing risk was swept out the bankers' doors, off their balance sheets, and on to a third party customer.Sweet…:-)

Who were these (incorrectly or fraudulently AAA rated) toxic assets sold to?As institutional banking clients, funds (including pension and insurance funds) were targeted customersfor many of the structured investment products that were created by the major investment banks.Bankers created these products through securitization.

At the time, all funds, trusts and accounts –especially those that were limited in the type and grade of investment they could purchase –were on a very competitive scavenger hunt for yield.… specifically higher yields in an environment where the flipside of easy access to seemingly unlimited credit was dismal returns.Also, with virtually unlimited credit available – there was a seemingly endless abundance –with an excess of 'money' to be invested, competition further depressed returns.

Pension and Insurance funds seek the highest available investment yield.That makes perfectly good sense…:-)They're also obliged to purchase securities that carry the applicable good housekeeping seal of approval investment rating.

Correspondingly, investment banks feted fund managersto a lifestyle they were not otherwise accustomed replete with excess, collusion and graft.Everyone was doing very, very well, and money really wasn't an object.It was only later that all of it turned sour.

So, in short, funds (including pension and insurance funds) are carrying on their balance sheetsthe same toxic assets that are rendering the banks themselves insolvent.

What is a securitized asset?

Bankers began with a pipeline of inventory (freshly minted debt) as raw material for the production of securitized assets –that would include corporate mezzanine loans they carried temporarily on their booksand debt of other kinds (i.e. aggregated home loans, consumer credit, auto financing).

'Debt' would be chopped apart into parcels or allocations of riskthat were then assembled with risk parcels or allocations of other debtin tiered tranches (tiered with various proportions of risk quality).to create 'new' hybrid collections of risk exposure -and new securitizations to sell.

Banks also packaged and sold collateral debt insurance (CDOs)on the performance of the original debt,and also on the performance of the new hybrid securitizations, or collections of risk exposure.(A collateralized debt obligation is basically a guarantee on the performance of payback on some form of debt.)

The really neat thing, from an investment banker's perspective, about securitized assetsis that perpetual product can be made from a stream of debt..:-)

Meet CDO squared.The CDOs that were packaged and sold in the example abovecould then be chopped apart into parcels or allocations of riskthat were then assembled with risk parcels or allocations of other CDOsto create a 'new' hybrid collection of risk exposure – and new securitizations to sell.These are referred to as CDOs squared…:-)

This is the magic of securitization – and this is where the money (the fees!) were for investment banks.Securitization provided the potential for creating unlimited side bets.For example, bankers not only sold CDO insurance to the underlying holder of the debt paper in question as a hedging (insurance) tool –but to any number of other third parties as a wager – as a side bet.The side bets that were sold to speculators dwarf those who purchased CDOs as a legitimate hedge (by hundreds or thousands to one).

This is how over $1.4 quadrillion notational value in global, outstanding derivatives contracts were amassed by summer 2008.

But this could have never happened without credit as fluid as water out of a faucet.All of that money (read credit) sloshing around was impossible to deny – and it all needed someplace to go.Clever people were paid for their time to think up new investment vehicles to hold all of it.And then Robert Rubin and Larry Summers and Phil Gramm and others knocked the legs from under Glass-Steagall,and this was bound to happen.

… and with the Greenspan Fed making it clear that it was backstopping failure (i.e.moral hazard) all the banks had to play to compete.

epilogue

Understandingly from their perspective,politicians – and leaders if we have any – are motivated not to address this situation.

Is this why the bankers,who have permeated the White House,are getting such a great deal?

Are the bankers holding the White House hostage?Literally?

Is this why banks are not forced through standard FDIC bankruptcy (see S&L debacle, 1980s)?Is this why taxpayers will take the hit before banking bond(debt)holders?Is this why the Goldman/Citi clique presently dictate Executive fiscal policy?

Here, I think, is the money shot, the elephant under the bed:if (when) the banks are taken down –if all assets are revealed and 'marked to market' –it's not bank failure itself that's prohibitive –but that banks bring everyone down with them.This is the rub, I think.

Because if critical (i.e. pension and insurance) funds are unable to fulfill their commitments – that will collapse social order.Nearly overnight.

This has the potential to become a catastrophic political blunder for Obama, who, now disregarding the sound advice of those who for two years guided him ultimately to election, is favoring the “same-old” prescription of his tax-cheating appointee.Hmmm…didn’t Wall Street and the financial industry provide candidate Obama with the lion’s share of corporate campaign contributions?Meet the new boss, same as the old boss: Change we can believe in…

The only people that can fight off the idiotic proposals by Geithner/Summers is the bond mafia. If there is a major sell off, and US interest rates spike, they’ll be forced to trash their so-called plan.

Anonymous @ 6:43am said:“The whole point of this bailout is to try to re-ignite demand in the US to counteract the loss of demand from those loosing jobs and those who have had access to easy credit removed. This could work except for the fact that it does very little for global demand in a time frame which stops the inevitable decline. With the best will in the world the US treasury will struggle to reverse job losses in Japan and China in the short term. The US government needs to stop focusing on banking, lending, debt, credit and needs to start thinking about sustainable job creation. Money spent on apprenticeships, scholarships, research grants, cooperative education programs, new business grants, career planning, small business planning will probably be the wisest money spent in the long run.”

Brilliant, great comment. Our spending will leak out to foreign countries.

But I disagree with the phrase “with the best will in the world.” Indeed that is the intent. We are saving the world not ourselves. Obama’s adminstration is doing it intentionally. I would love to see what secret international agreements he has going behind the scenes.

I do know that China threatened him clearly that if he did not keep up the value of the US currency, they would dump US Treasuries. It was in the Chinese press, probably not the US press. But this package smacks of internationalism.

I am so sick of it. I want my country back. And I’m not ignorant, I have been to the same schools they have.

The only financial institutions in this country is worse shape than the large banks are the federal and state governments.

People like to believe the government can solve the problem by creating money, but they can’t. The government can create currency but they can’t crate value. Investors already know this; they’re poised to invest in companies who can profit from stimulus plays, but those investments will still be short-term (4 years or less) and the investments will then be yanked.

Only the final sentence in your post was correct. We should do what is in our best interests. There’s often a game-theoretic aspect to it: by being tough on other players, one can enforce their cooperation. It’s time to play hardball.

I think Ben has it right. The banking industry has tied itself so tightly to the security, investment and pension funds, that if they were allowed to fail (or their toxic assets purchased for what they are worth), that the collapse wouldn’t affect just the banks but pensions, securities, and every investment made in the US, with shockwaves affecting every other banking industry in the world.

IOW, our entire lifestyle is being held hostage by a banking industry that is hanging on by its fingernails, and expects us to pay up or we go over the cliff with them.

Bendal you’re right as far as you go. If we restructure the banks, there will be a lot of fallout. Transparency will be very painful.

But the alternative is worse. The banks will not be healthy unless the taxpayer is ripped off for all those bad obligations anyway. Nobody is being fooled, see how much information and discussion is available.

Better to do it explicitly, then at least we’re not subsidizing bank management, shareholders, bondholders and counterparties too.

If you want to refer to a good bank plan, please refer to (mine, which as far as I know was the original, at least in suggesting a good bank spin-off as a solution to the problem of dealing with hard-to-value assets. Buiter’s latest post – “no-brainer”, “obvious”, etc – seems to be a response to my complaint that he had not acknowledged the contribution of comments on his blog to his thinking, which seems to have changed completely since his rather arrogant presentation at Jackson Hole in August, in which he asserted that the problem of valuing troubled assets could be easily solved by reverse auctions.

I think Ben’s ideas about the Big Question and its answers are very interesting, but I’m confused about one point: if some toxic securitized assets are owned by the pension funds, and some toxic assets are owned by the banks, is the problem with price discovery of the toxic assets on the banks books that this will somehow force recognition of losses on similar assets held by the pension funds? I’m not clear what the linkage is, in your theory, between discovery of the value of assets on banks’ books and harm to the pension funds.

I realize this current strategy is just paying bankers’ salaries, but ISTM that the Obama Administration has become convinced that any other alternative will utterly destroy the financial industry, and with it, every bit of savings/investments “we, the people” have accumulated.

Try telling a politician you just eliminated everyone’s retirement fund/savings plan/college dreams by your deliberate actions and see how fast they try to do anything else.

It doesn’t help that the banking industry was one of Obama’s leading campaign contributors, either.

ISTM that Obama has got a Hobson’s Choice ahead of him. Continue draining the US reserves of credit to feed a dying banking industry, or put a bullet through their heads immediately. One has them drag us slowly into the abyss, the other sends us there much faster.

Ben took a little while to get to the ‘money shot,’ but he is correct about the real consequence of acknowledging that many big banks are insolvent — pension funds, insurance companies, pimcos, etc are in the same boat, either directly or by holding big bank and corporate bonds and preferreds.

Hence the political fright alluded to by Martin Wolf.

Eventually Mr. Obama will conclude that he will be a one-term president unless he forces a real house-cleaning, and the subsequent switch in behavior from on high will be binary. We should remember Nixon and the gold standard. One day rock-solid, then gone the next.

My guess therefore is that Mr. Obama will frustrate many and ‘wussy on,’ but only for awhile longer. The funny-money is already lost forever, so why get too far in front of his constituency in terms of eventually allocating the losses?

Several people (Bendal, Gentlemutt) are making excuses for Obama. I was making excuses for him til today, when I saw the Geithner bank bailout plan which is of course the Obama bank bailout plan. So I know the feeling and now preach with the fervor of the recently converted.

I will confess to an ideological component to my proposals. Even if something doesn’t maximize the expected utility of future wealth or consumption, it makes me (and probably others) feel better if there is more equality and more fairness. Call it Schadenfreude if you want but it’s not that I want others to suffer, it’s that I want to be equal with them. And that includes those who have less than I have now, that is, most people.

But nevertheless, BS isn’t faring too well these days. Honest treatment of the problem will probably work out best in terms of expected utility of wealth for most people, independent of other considerations.

If Geithner and ObamaBush doesn’t want to enact a “reign of terror” in dealing with the criminals and charlatans that are the “Captains of Industry” or “Masters of the World”, they should consider the potential that the people WILL go for said reign if the the government doesn’t.

Their “reign of terror” simply means poor little rich people have to kiss off a (large) fraction of their “wealth”. GASP! Maybe they will have to live like the rest of us! The People’s reign of terror involves real terror. It means, at the very least, physical pain, bloodletting, and on occasions, actual decapitations.

Either Geithner and ObamaCheney decide to enact their gentleman’s reign of terror (ie, force accountability) or we the people (all over the world) will do so OUR way.

I STILL don’t get the entire fantasy of even insuring the crap assets. The anchor of these “assets” is said to weigh in at 10s of trillions of worthless dollars. How the HELL can a few billion, or even a trillion or two, dollars do ANYTHING.

When the liabilities due to the real value of these shit assets is greater than the total of all the money in the world or all the GDP of all countries conbined, how does Geithner and his idiot fellow traveler criminals being to think they can pay any amount of money into the system and fix it?

Seriously. Answer me that question. Are the many expert estimates of the actual liabilities held by these banks totally off? Are the banks truly only a trillion or so in the hole? Or are they 10, 15, 20 trillion in the hole?

(As for trains running on time, NPR reported years ago that a British journal did a study and concluded that Mussolini didn’t make the trains run on time, but pushed that image through every outlet at his disposal.)

Now, second, we will work together with the Federal Reserve, with the FDIC, and with the private sector to establish a public-private investment fund. And this program will provide government capital and government financing to help leverage private capital to help get private markets working again. This fund will be targeted to the legacy loans and assets that are now burdening many financial institutions.

Is Geithner essentially suggesting our government needs to loan money to people so they can buy toxic assets from banks on margin? If so, this is one of the most preposterous proposals I have ever heard of.

Geithner/Summers/Bernanke’s $1.5 trillion dollar Wall Street bank bailout plan cannot possibly work, it simply throws good taxpayer money after bad. It props up the same failed bank managers who will just do the same things that got us into this financial crisis. The IMF’s studies and the experience of the RTC clearly proves that the sooner bad bank management can be replaced the lower the rescue bill will eventually be because these terrible bank managers just continue to dig their financial hole deeper. Instead, lets clean up the problems now by showing these bank directors, senior managers, equity and bond holders the door; let the failed institutions go bankrupt.

The politically connected ruling elite get fabulously richer while the rest of us get screwed into paying taxes to bail them out. This type of “freedom” sucks!

You’re right when you say Obama’s team is making this up on the fly. THat’s why there was no announcement yesterday. They hadn’t started yet. Obama says Geithner needs to work on stimulus? Huh? I thought stimulus was bogged down in the Senate? The Senate gives a shit what Geithner thinks?

Not only is the Big O as big a liar as Bush, he’s not as smart. He’s not up to the task. We’re hozed. Gold, Guns and God, baby. That’s all we have left.

I’m not making excuses for Obama; I think he’s acting as any politician would when faced with a choice that would mean the end of his political career: he takes any other choice but that one.

Declaring the majority of banks in the US insolvent, or buying their bad assets at their actual worth, would probably collapse the entire financial house of cards, leaving millions without pension/retirement/college funds, bankrupting insurance and investment companies, and creating havoc all across the economy.

No politician that has that on his resume’ is going to get re-elected.

I’m not at all sure what would happen if he nationalized all the banks, or created a new “US Bank” to transfer good assets into, but it appears he’s not going to do either of those, even though they may work out better than what he really is doing.

“A Three Legged Stool” as Obama keeps aluding in reference to the new Economic Recovery Act to and which Geithner “unveiled” today had the impact of…..a three legged stool.

It was breathtaking to watch the grad school level of economic sophistication and the abject lack of understanding of rudimentary leadership skills. No attempt to rally public sentiment. Just further transparent attempts at self-aggrandizement (“We are facing a catastrophe that a)is not our fault and b)when we save you from it we should be praised).

Have I missed something or has nobody defined exactly what we are trying to do? What is our current definition of success? Forget about how we achieve it, I’m just wondering what exactly we (they?) are trying to achieve?

Are we trying to save the market as in the value of certain stocks, are we trying to secure investment (which may be related to stock value, but not necessarily equivalent), are we trying to save individual institutions (and so what does it mean to save them exactly?), or maybe we are simply trying to minimize losses? I cannot imagine that we are trying to circumvent losses because that would be like jumping out of a plane and then trying not to fall.

Obama also mentioned 90’s Japan last night quickly followed by his Bush-like premonitions of Armageddon if we don’t blindly follow his lead. Am I simply being naive to point out that, last I checked, Japan is still around somewhere. They survived, right? Does anybody actually believe we can prevent capital/productive loss?

This brings me back to my first inquiry: what exactly is the strategy? What specifically are we trying to accomplish here? Yes, I’ve heard about saving jobs, but whose job are we saving?

The current strategy or lack thereof so far seems targeted at preventing a specific type of loss for a certain percentage of the total population who are suffering from loss due to poor decisions. The net effect is that everyone with good judgment is being penalized.

In other words, it’s a bit like we’ve been playing a long night of poker and when we go to cash in the chips the bank tells us, you guys who were lucky enough to win are going to have to give some of that to these other guys who lost a lot so they don’t feel so bad.

I’d feel a lot better if team Obama would start focusing on managing our losses than trying to return to some previous status quo. I think if Obama did nothing we’d shave a lost decade down to about five or six years. Doesn’t our economy (not the market, but our economy as a whole) need this time to recoup? Generate enormous debt (not like we aren’t already there) and then this lost decade would be an improvement.

And that $500,000 salary cap is just political posturing. Worse it really sets the floor rather than the ceiling for pay. It tells Wall Street how much upfront they can pillage without us batting an eye. Wouldn’t it make more sense to scale executive pay as a percentage of profitability? Or at least scale total compensation against some kind of benchmark? If a single banker can save this country $100 billion, I wouldn’t blink an eye to give him/her at least $1 billion as a reward. That leaves $99 billion our kids won’t have to pay back to China.

The Canadian AssetBackedCommercialPaper case is an interesting one for those who haven’t heard of it. As far as I can tell, the value of the assets was (is being) determined via court-mandated negotiation.

I am all for bailing out the banks, the auto industry, and the rest of the bandits in line for free taxpayer handouts. Here’s a 4 point plan I envision for We the People:

1. We print trillions of new paper money and buy from these banks all foreclosed properties and commercial structures they now possess (i.e., GM plants, airlines, etc.),

2. We wait for the inevitable hyper-inflation to run its course, thus reducing the trillions of dollars in possession of these banks to little more than very rough and unsafe toilet paper,

3. We begin distributing the aforementioned properties among taxpayers according to their history of contributions to the IRS, and their proven entrepreneurial abilities. The more taxes one paid, the nicer a property he would receive. The same goes for businesses.

4. We won’t ever have a need for these blood-sucking megabanks since most property in the country would then be debt free.

The FINANCIAL STABILITY PLAN said “THESE BANKS ARE LEMONS”. Actually the plan is dealing with “The market of lemons”. If one cuts and pastes sentences on the blog sphere, including one or two from me (see my blog for example),one could get the same plan…

Banks only account for 20% of lending, but are where 100% of the voters funds are deposited. While there can be runs on depository institutions such as banks, there can be no ‘run’ on those who are responsible for 80% of total lending. Treasury should takeover the 14 ‘untouchable’ banks, and thereby eliminate the possibility of runs sinking the banking system, and eliminate distracting controversies over executive pay, moral hazard etc. Save the rest of the banks by taking over the 14 insolvent untouchables. Show the world this government is decisive and can take action.

Also, set leval lending play-fields so all lenders, regulated, supervised, and examined, like banks are , and the rest compete for loans in the same market. Everyone will benefit, except those now-unregulated etc.

Yves- hard hitting and wonderful, thank you. The oracle of the zeitgeist indeed.

I can’t tell if this is grasping at straws but Krugman wondered in his blog if the “plan” is a Trojan horse. And my money is that is a wish.

Still, there’s a case there that bears contemplation. There is no win whatsoever for Obama in destroying the banking system with words this month. Letting Rome burn is good entertainment only if you don’t live smack in the middle of it. Declaring a ‘good bank’ is a political impossibility for it’s instant and irreversable consequences.

It’s far more in Obama’s interest to foment a private sector conflict that stays in the headlines while the technical organs quietly prepare the graves. You don’t rise in any corporate organization without Machiavellian awareness like this.

Not that there is any solace in this view. Hopefully Obama keeps Volker around to make sure Geitner smells his own mortality. By now Geitner has certainly imagined what his options will be in the future world of finance. He did that before accepting the job.

I’m off to see my therapist before this hopefulness makes me really stupid.

Agree with the majority..Geithner and Obama are off to a shaky start and appear to be over their heads.. not a good sign.Same old appointees and programs, Obama will need to quickly change direction or he will go the routeof Hoover and Carter. Geithner and Summers needs to go, terrible choices.

No serious regulations applied and no real plan to attack the housing issue.

Comes a time when a generation needs to define itself as did the John Brown’s of the 1840’s or the tent camps and bonus marchers of the 30’s and later the Vietnam, Civil Rights and Watergate protests of the 60’s-70’s. Seems like our country has lost it’s stomach for true change. Myself included, we all vent on the blogs and yet fail to do the old school thing and get in the faces of these corrupt people. Maybe we need a little dose of old school McCarthyiasm or Nuremberg… the trees and bushes need shaking.

Paulson originally asked for the $700 billion TARP money in September to buy up toxic debt to prevent the sky from falling amidst quadruple digit swings in the Dow, yet instead later used funds to recapitalize private commercial banks by the Treasury buying preferred stock in them. The FDIC also instituted its Temporary Liquidity Guarantee Program so that any non opt-out commercial bank could have any new borrowing guaranteed for 100 basis points. The idea here is to recapitalize the banks. We also have a degree of socialism, e.g. BOA is now Bank Owned by America.

Why did Paulson change plans? Reason is that if banks sold off their (level III) toxic assets, then they would have to realize losses mark to market, many banks would be balance sheet insolvent, and theoretically should have to be taken over by the FDIC. Paulson could have paid more than market price for these bundles of mortgage backed assets, but how do you decide on which price to pay, or even what the market price is? The whole purchase of toxic assets would have been a mess. Also would have fostered fraud and corruption if not involving some market valuation.

Failure is not a dirty word. Inasmuch as having a firm which produces $10 widgets at an input cost of $12 destroying $12 resources to produce a $10 widget should be shut down, it is also good thing to have financial institutions fail and disappear if those institutions take resources and turn them into a lesser value. Markets have a good way of promoting efficiency.

The best economic policy would have been to have the FDIC take over failed banks and sell their assets and deposits customers to viable banks as quick as possible. This is how the system was supposed to work. The problem with this is that the FDIC is insolvent. The FDIC had about $26 billion in the fund to insure $4.5 trillion in bank deposits before the bailout, joke – half a percent reserve fund, would have been shut down by regulators years ago if a private insurance company, and things are now much worse since both deposit liability limits were raised from $100,000 to $250,000 and the Temporary Liquidity Guarantee Program was established. The FDIC is not viable enough to over bad banks, just one mere Citi failure would make the FDIC insolvent. No bank runs reminiscent of the Great Depression at all costs, so hide FDIC inadequacy. So the bad politics of this is that the Fed via TAF and Treasury via TARP recapitalize a bunch of bad banks which really should be shut down. All that TARP money should have been used to recapitalize the FDIC instead of buying possibly worthless preferred stock at above market prices and allowing inefficient banks to continue operating, and taxpayers will pay the bill for the continued losses.

The whole Temporary Liquidity Guarantee Program additionally puts a monkey wrench in the otherwise efficiency of capital markets by equalizing the cost of capital (100 basis points above treasuries) for all banks irrespective if good or bad banks, i.e. efficient or inefficient banks. Consider this – what is government expanded the program to all corporate debt – all corporations would not fail and could issue new debt at the same interest rate? Would capital flow flow to the most efficient corporations with best prospects? No, there would be inefficiency lowering the standard of living. How about we do the same with the mortgage market – no discrimination, all borrowers, prime or subprime can borrow at same rate? Taxpayers (and treasury bondholders via inflation) will pay the bill on these do something/anything to fix the problem programs which actually make the problem worse by fostering moral hazard and a continued inefficient allocation of capital by institutions which otherwise by market forces should be shut down.

Adding to what Joe Pomykala wrote: equalizing the cost of capital is what created toxic assets in the first place. For example, when interests rates are level across all borrowers, those with the most to gain are those with the highest risk.

Cost is perhaps too limiting of a term here. What we should be concerned about is the availability of capital, where cost is only one factor of availability. Even at high cost, surplus capital can easily become toxic as we have experienced with bad mortgages that were then dumped in packages to government subsidized entities. High availability of revolving credit likewise results in toxic assets.

Therefore I find myself at a loss when all I hear are people talking about freeing up the credit flow. It was this free flowing credit, an equalizing of capital, that was one of the factors that placed us in this mess.

Yes, infusing public money into the private sector has worked in the past, but the difference there was that we had a technology revolution that compensated for the excess capital. Today the rapid transition from a production to service economy clashed against the high credit availability. We saw this with dot.com, too many service industries emerged that weren’t in demand.

Until recently we’ve always been able to count on making more tomorrow to pay today’s debt. Now income is dropping against a rising debt. The best thing that can happen is for credit to freeze, consumers to restore their own confidence by returning to savings, and prices to collapse. It will hurt a lot in the short run, but will be good for us long term.